The purchasing power of the UK State Pension is steadily dwindling. And savers and investors today know we need to stash some cash away if we want a passive income to supplement our retirement years.
To me, investing in shares on the UK stock market is the way to do this. Shares have beaten other forms of investment hands down for more than a century now. Today I’m looking at some key strategy tips that I’ve picked up over the years from the experts.
The most important one is to start investing as early as we can. The difference a few extra years can make at the start can be quite an eye-opener. I’ll come to that shortly, but first I want to cover one other thing that can make a big difference.
Pay off debt
Debt can put a big dent in our long-term passive income plans. Warren Buffett is possibly the most successful investor who’s ever lived. And through his Berkshire Hathaway investment company, he’s produced an average annual return of a massive 20%.
But credit card debt at today’s typical rates would be enough to wipe out even Buffett-style investment returns. And compared to the single-digit annual returns that most of us are more likely to achieve, debt could destroy any hopes of achieving a passive income in retirement.
Most experts then recommend paying down debts before starting to invest, excluding low-interest mortgage debt.
The difference the years make
How much difference will it really make if we start investing as early as we can? Let’s imagine two young investors (who I’ll call Lily and Jack, picked randomly from currently popular baby names). Both are aged 20 and have just started started similarly paying jobs.
Lily invests £500 per month in UK shares right from her first pay packet. Let’s suppose she achieves an average annual return of 6.5%. UK shares have returned close to 5% plus inflation for more than a century, so I think that’s reasonably conservative.
After 40 years, Lily will have accumulated a little over a million pounds that she can use to generate passive income for her retirement years, and she’ll still only be 60. OK, I accept that not everyone will be able to afford that much from their first salary and that even if they can, returns can be less than I assumed.
10 years later
Jack, meanwhile, spends a decade of blowing all his spare cash before he starts to think about his long-term future. He then knuckles down. But to match Lily’s retirement pot by the same age, Jack would have to invest twice as much per month. Investing £1,000 every month for 30 years, Jack would also hit the million pound passive income pot.
In total, Lily would have invested £240,000 over 40 years to reach her million. But reaching the same goal would have cost Jack £360,000 over 30 years. And if Lily had kept increasing her monthly investments as she could afford to, Jack would probably have no chance of ever matching her.
I think that’s two lessons for those of us seeking to build a passive income pot for our retirement. We should pay off any debt. And start investing as early as we can.